It’s The Dollar, Stupid!

Submitted by Paul Brodsky via,

We think the markets have it fundamentally wrong. US investors are anticipating a cyclical shift towards economic expansion via new tax incentives, business de-regulation and Keynesian government spending that promise to increase output, demand and asset prices. However, there is a far more influential driver of future asset prices – a structural shift that has begun but has yet to be acknowledged by economic and political authorities, and, judging by financial asset markets, by most investors. We expect weak equity markets and a strong treasury market beginning in 2017.

It’s the Dollar, Stupid.

The financial model used by advanced economies since 1971 is quickly losing its ability to support economic growth and rising asset prices.1 Western economic policy, which had previously relied heavily on credit creation from 1971 to 2008, was replaced in 2009 by monetary policy that relied heavily on base money creation through asset purchases. The structural shift in central bank focus from credit to monetary creation marked a paradigm shift in the decades-long finance-based economic model – from the leveraging phase to the de-leveraging phase.

The Fed shifted to relying on a communications policy in 2013, which focused on renewing the broad perception that by “normalizing” US interest rates the economy would again begin to react to credit incentives it could manage. It also emphasized the need for fiscal stimulus, which would ostensibly create demand and stimulate production growth. Last month the Fed hiked overnight rates for the second time in two years and the markets expect it to hike rate three times in 2017.

Fed rate hikes tighten credit conditions in the US and, given the continued execution of QE by other major global central banks, increase the exchange value of the dollar. A stronger dollar theoretically increases other economies’ exports into the US, provided that US consumers and businesses are able to maintain the same level of demand for foreign goods and services. This is an open question.

Donald Trump’s election raised hope that new tax incentives, business de-regulation and Keynesian government spending will create sufficient demand. The dollar and US financial markets have reacted in sympathy with stock prices rising and bond prices falling…despite the Fed’s renewed credit tightening. A strong dollar would tend to attract global wealth to the US, wealth that theoretically could find its way into US risk assets including US equities. Thus, US equity strength since the election reflects a strong dollar, which is based on the combination of Fed rate hikes and renewed hope for US government stimulus.

This is not the first time the Fed has had to actively increase the exchange value of the dollar. Paul Volcker’s Fed had to hike overnight rates to 20% in 1980-81 so the dollar would be reaffirmed as a store of global value for US trading partners, including OPEC. We believe the Fed is doing the same today, in spite of its de-stimulative impact, because it wants to attract global capital to US banks and asset markets. Doing so would ensure USD hegemony, which would be necessary if/when global leverage leads to hyperinflation and multilateral trade and currency wars. Once substantial wealth is held in dollars and dollar-denominated assets, the US political dimension and the Fed, through the BIS and IMF, would be able to control the terms of a global monetary reset, which in turn would de-leverage balance sheets across currencies and economies in a controlled manner; in effect, a pre-packaged bankruptcy in real terms.

Nothing has changed structurally (or cyclically) since the US election. Global central banks are de-leveraging their banks through QE, with the exception of the Fed, which already did. Commercial bank liquidity and solvency is a precondition for a global monetary reset. The table is being set for more, not less, central bank intervention in the form of monetary inflation, and more intervention from the political dimension, which would choose which non-bank creditors (and debtors) will experience credit deflation.

The markets have it wrong

We believe fiscal measures like those being speculated about now in the US, even if successfully executed, would fail to generate meaningful new production and demand within the US and global economies. Financial markets are vulnerable to a reversal of their recent trends.

We cannot place specific figures or exact times when benchmark equity and fixed-income indexes will reverse current trends; however, we are increasingly confident that US and global economies have begun to experience necessary structural changes that directly impact: 1) incentives to produce and consume, 2) the fundamental manner in which the political dimension approaches monetary and fiscal policies, and 3) the way in which investors think about assets, liabilities, economics and capital markets.

The secular US fixed income bull market, which began in 1981 when the Fed embarked on what would become a forty five-year credit easing regime that benefitted, treasury, mortgage, corporate, municipal, small enterprise and consumer borrowers, and would eventually spread globally to other advanced and emerging bond markets; which allowed the US government to deficit-spend (eventually without the expectation of recourse) its way to unrivaled military might that defeated and then contained potential hostile threats abroad; which provided primary funding for bank and shadow bank lending that gave the US dollar and financial markets status as the ultimate sanctuary of global wealth; which provided a platform on which global bank and non-bank counterparties could swap contingent liabilities amounting to many times the size of underlying cash markets without fear of regulatory interference; and which provided speculators across other asset markets (including real estate) to continually sponsor unsustainable valuations, no longer produces capital or serves an economic purpose, and is almost over.

The secular US equity bull market, which not coincidentally also began in 1981 and served as the principal funding mechanism for great advances in digital technologies, communications, finance, logistics, health care, energy, retail, and other industries; which helped raise and maintain competitive trade advantages for the US and its allies; which expanded capital expenditures, productive output and consumer demand; which helped collateralize expansive public and private credit issuance and debt assumption, in turn creating a positive feedback loop that further increased nominal production, consumption and asset prices, and which created nominal wealth for US and non-US asset holders, is also in its evanescence.

Stock and bond markets in advanced, financially-oriented economies, have devolved more into political imperatives necessary to maintain social services and the perception of wealth, rather than serving as the traditional means to build and price wealth and capital. They no longer serve societies or global trade.

In over-leveraged economies, stock and bond markets become co-dependent. To sustain market prices, debt and equity require nominal output growth. To sustain market values, they require real output growth. The only way to increase nominal output growth and raise nominal equity prices in a highly leveraged economy with leveraged currency is to raise the quantity of credit, which must eventually reduce real output and asset values. The question before us is whether “eventually” is occurring now.

The primary reason we think stocks are peaking is scale. Aggregate market caps, valuations, revenues and earnings of public companies cannot be sustained by the level of real production in the underlying US and global economy. We think bonds are on the eve of reconciliation for the same basic reason: the scale of systemic leverage has already begun to reduce incentives to expand credit for capital formation, which, in turn, promotes debt deflation.

We expect debt deflation coincident with central bank monetary inflation, which would offset the deflation…on paper (like feet in the oven, head in the freezer producing a reasonable average). Before this occurs, we expect a financial or economic event that focuses public attention on the leverage problem.

Drilling Down

The incentive to invest in the stock market is to build wealth, which is accomplished by generating positive real (inflation-adjusted) returns. This presents a problem looking forward. Many of the companies the market rewards most in terms of market cap drive goods and service prices lower by innovating and connecting buyers and sellers (e.g. Amazon, Facebook).

Against this backdrop, the Fed’s economic mandate from Congress is to work towards stable prices and full employment. To do so, it has a specific annual inflation target of 2%. If the Fed is successful in this target, then it will reduce the purchasing power of US dollars by more than 64% over the next 25 years:

As the table above makes clear, through its specific economic mandates and acceptance of the Fed’s 2% inflation target, the US Congress effectively promotes a decline in the value of ongoing savings earned and amassed by American labor. For investors, the policy also acts as a hurdle over which investor returns must rise to create positive real returns (i.e., wealth).

On one hand, commercial competition is naturally driving prices lower, making goods and services more economical for producers and consumers, and equity markets are inflating the asset values of businesses that deflate prices. On the other hand, the Fed is trying to drive goods, services and asset prices higher, which would drive the purchasing power value of savings lower.

Since 1998, asset prices (portrayed by the Wilshire 5000 on the graph above) have been supported in great part by Fed liquidity and debt-driven buybacks while US economic activity, (portrayed by monetary velocity), has been in secular decline. It is tough to sustain 2% inflation for very long through financial maneuverings when domestic economic activity continues to weaken. Any further inflation the Fed might help create (as it hikes rates!?) will not be demand driven, but rather the result of more financial leverage.

It can’t persist much longer

The current excitement among US equity and credit investors over the promise of a best-case stimulative mix of deregulation, tax cuts, and Keynesian government spending has created a very optimistic market tone. The Fed has further intimated December’s rate hike was the start of a new regime of interest rate normalization. Together, these dynamics have caused treasury yields across the curve to rise. Rising treasury yields in past business cycles have further signaled economic recovery, which has seemed to confirm to most investors that economic and equity market optimism are warranted. We disagree.

Any fear of demand-driven goods and service inflation is un-warranted given 1) the already-leveraged nature of public and private sector balance sheets, 2) the need to perpetuate the relative strength of the dollar, and 3) the expectation of further Fed rate hikes. Even a successful multi-trillion dollar US government spending program that provides a few jobs and necessary American capital improvements could not provide sufficient consumer demand to overcome US and global balance sheet leverage and the attendant necessity to maintain US dollar strength to sustain the current monetary system.

The graph below plots the secular decline in long-duration treasuries against the year-over-year rate of US goods and service inflation. (The gap in 30-year treasuries is due to the elimination of Long Bond issuance from August 2001 to February 2006.) We believe the rise at the extreme right of the graph representing their most recent trends is not indicative of the next big move for long-duration treasuries.

Given the need to maintain the US dollar as the fulcrum of the US monetary system, the most influential input for future treasury yields has become global output, which is in secular decline. This trend is logical, established and seems to be accelerating. It is logical because the secular post-War decline in global output growth was only interrupted by the emergence over the least twenty years of large new economies like the BRICs. The continuation of that secular downward trend would make sense once those emerging economies are established. The graphs below confirm that balance sheet leverage within emerging economies have surpassed those in developed economies and that, not surprisingly, global output growth is truly struggling. As a result, we expect one last spasm that takes long-term treasury yields to new lows.

Relevant Economics for Equity Investors

Investors will soon be forced to better understand the macro world around them. The perception of the deflation/inflation metric should determine near term and secular debt and equity market directions.

Prices are determined by supply/demand equilibriums – where the supply of goods, services, labor and assets meets the demand for each. This is theoretically true in classical economics. However, in the current flexible exchange rate monetary system administered by banking systems and the political dimension (i.e., a fiat regime), both supply and demand are determined by the prevailing quantity of credit available to producers of supply and the quantity of credit available to consumers who create demand. (Credit is simply a claim on base money, which is created by central banks.)

The most insipid structural problem threatening economic vitality and equity market returns is public and private sector leverage. High and rising debt-to-GDP ratios, which threaten economic liquidity, and high and rising debt-to-base money ratios, which threaten balance sheet solvency, must eventually be reconciled. Aging demographics within the world’s largest economies is accelerating the timing of the necessary reconciliation, which must occur through debt deflation, monetary inflation, or both.

Thus, investors seeking to create wealth by investing in broad equity markets face a fundamental structural problem caused by the irreconcilability of 1) naturally occurring commercial deflation, 2) economies and political systems that rely on inflation, and 3) the crowding out of consumption and investment by necessary debt service.

Consider the 2% inflation target established by the Fed and accepted by most political economists. See table, page 4.) The target ostensibly limits the annual loss of purchasing power to 2%, and therefore it is generally thought that having such a target is in the best interest of American workers. Such an argument is inaccurate, naïve and disingenuous. As the graph on the previous page shows, the Fed was unable to cap goods and service inflation when energy prices spiked from limited supply in the 1970s, and unable to cap inflation at 2% throughout the credit-led secular bull market in corporate and property equity in the 1980s, 1990s and 2000s.

Goods and service inflation more recently has struggled to rise to 1.7%, where it stands today. A 2% inflation target has shifted from a target to preserve the purchasing power of the dollar to a target to ruin it. Nowhere in the public discussion has this been mentioned. As discussed above, we think the Fed’s “fear of inflation”, which is ostensibly driving the new rate hike regime, is a necessary public narrative that will let the Fed pursue its true objective – a stronger dollar and deflation amid a contracting real economy.

Even if US domestic economic activity were to somehow reverse its secular downtrend enough to warrant current equity valuations, it is difficult to conceive how much more asset prices could rise – especially in real terms. Simple math, anachronistic economic policies and poor demographics pose insurmountable barriers for creating wealth through public share ownership. (We further discussed the current negative implications of over-valuation and the negatively convex nature of equity markets in The Grift.)

Can the Establishment really be that wrong?

In classic economics, both employment and inflation are derived from production. Political economists, a moniker that defines the academic discipline from which the great majority of contemporary economists spring, argue that a fully-employed labor force suggests that rising labor inflation will lead to rising goods and service inflation. Thus, the Fed is trying to raise rates currently, citing the second Fed mandate – full employment – which threatens stable prices. The ultimate policy goal is to protect the US (and global) economy from shrinking.

According to logic and classic economics, there is nothing wrong with a shrinking economy. Why? Because an economy should shrink commensurate with a rise in leisure time. Seriously. An economy is theoretically supposed to serve its factors of production. The more economical it is, the more leisure time it produces for its participants. (We suspect economies are called “economies” because they were formed naturally as systems that actually economized.)

In such an economy, only theoretical today, deflation would be a good thing because it would increase the purchasing power value of savings produced from past labor. In fact, an increase in deflation (i.e., an increase in declining prices) would actually raise real (inflation-adjusted) GDP because the gain in the dollar’s purchasing power from deflation would offset the declining volume of goods and services (nominal GDP). (We suspect this fundamental economic truth is the reason Congress’s mandate to the Fed includes only stable prices and employment, and not economic growth.)

The graph below shows the decline in the American work force since 2000. It should not strike you as alarming, given 1) all the great new innovations and technologies replacing human capital and 2) the expansion of global human capital from emerging economies. Tell us again, we ask sarcastically, what “full employment” is?

Market cap-weighted indexes notwithstanding, it may be worthwhile here to ask yourself again why an increase in the majority of US equity shares is generally perceived as a given as the US economy becomes more efficient.

Why it is all about the Dollar Now?

In today’s global monetary system, currencies are tranched liabilities of: 1) commercial banks that create deposits through the lending process; 2) central banks on the hook to collateralize member commercial banks that create deposits and credit without commensurate reserves or circulated currency (base money), and; 3) treasury ministries that ask constituent factors of production to have faith that its taxing authority and, as has been demonstrated throughout history, its ability to wage war to loot enough resources outside its taxing domain to protect its currency’s purchasing power value.

As liabilities without directly-linked offsetting assets, the purchasing power value of currencies are always susceptible to dilution. Dilution comes in the form of credit issued by banks (and, potentially, non-bank lenders) that is either not collateralized by assets or collateralized by assets that themselves are liabilities (like Treasury notes). The wider the gap separating the amount of un-collateralized credit denominated in a currency from that currency’s base money (bank reserves and currency in float) – the ratio that determines monetary leverage – the greater the amount of future monetary de-leveraging will have to occur. (De-leveraging must ultimately occur so that debtors can service or repay their obligations and so producers have incentive to continue to supply goods and services in exchange for that currency.)

We expect global monetary authorities to protect the dollar as long as they can and we expect them to fail. Stocks and bonds will react violently; stocks and weak credits falling, treasuries prices rising (at first). That failure will lead to hyperinflation – not driven by demand, but rather by central bank money printing. A new global monetary understanding will then emerge.

We expect weak equities and a strong treasury market in 2017, as they begin to discount this fundamental structural shift.

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HuffPo Turns On Obama: He Presided Over The “Destruction Of The Democratic Party”

In yet another “exit interview” earlier this week with David Axelrod, Obama took the opportunity to remind us once again just how awesome he is.  In doing so, he noted that he was “confident” he could have beaten Trump in 2016 and implied that Hillary lost, not because of his failures in the White House, but because she was lazy, complacent, boring and arrogant…although his word choice was way less direct and more on the passive aggressive side.

Apparently these passive aggressive attacks didn’t sit well with the Huffington Post’s senior political editor, Sam Stein, who appeared on MSNBC’s Morning Joe with some rare honesty about Obama’s political legacy.

“Yeah, I mean this was as much a dig against Clinton as it was Trump from President Obama.”


“You look at the destruction of the Democratic Party under Barack Obama’s leadership and you have to wonder, what was the political — what were the electoral benefits that he gave to the party?”


“He leaves them in a much worse position.  The states are decimated, they lost control of the House and Senate, the governorships are decimated.”


“Maybe [Obama] is a gifted candidate. He won election twice by substantial margins, but his legacy as a politician is a bit muddied by all that.”

Careful who you attack, President Obama, the HuffPo likes you but not if you’re going to attack their chosen one.


* * *

For those who missed it, here are the details of Obama’s interview with Axelrod from earlier this week.

The ever humble Barack Obama has just wrapped up yet another “exit interview,” this time with democratic political operative David Axelrod, in which he effectively throws the entire Hillary team under the bus for not connecting with voters while declaring that he would have beaten Donald Trump.

While recognizing that “a lot of people” now think that his whole “Hope & Change” mantra was nothing more than “a fantasy,” Obama said he was confident he could have “mobilized a majority of Americans” where Hillary failed because he is better able to articulate the message of “Hope.” The full interview with Axelrod can be heard on CNN.

“In the wake of the election and Trump winning, a lot of people have suggested that somehow, it really was a fantasy,” Obama said of the hope-and-change vision he heralded in 2008. “What I would argue is, is that the culture actually did shift, that the majority does buy into the notion of a one America that is tolerant and diverse and open and full of energy and dynamism.”


“I am confident in this vision because I’m confident that if I had run again and articulated it, I think I could’ve mobilized a majority of the American people to rally behind it,” Obama told his former senior adviser David Axelrod in an interview for the “The Axe Files” podcast, produced by the University of Chicago Institute of Politics and CNN.


Somehow Obama still seems to be convinced that the American people are simply longing for a few more eloquent speeches from polished politicians rather than actual change in Washington.  That said, for some reason we doubt voters chose Trump for his “eloquence”…big league.

Not satisfied with simply reminding us once again that he would have beaten Trump, Obama also decided to take a few more parting shots at Hillary by basically describing her as lazy, complacent, boring and arrogant…not in those exact word, of course.

“If you think you’re winning, then you have a tendency, just like in sports, maybe to play it safer,” he said, adding later he believed Clinton “performed wonderfully under really tough circumstances” and was mistreated by the media.


“We’re not there on the ground communicating not only the dry policy aspects of this, but that we care about these communities, that we’re bleeding for these communities,” he said. “It means caring about local races, state boards or school boards and city councils and state legislative races and not thinking that somehow, just a great set of progressive policies that we present to the New York Times editorial board will win the day.”


Meanwhile, Obama also reminded us that he’ll use his retirement to recruit and develop “young Democratic leaders” including organizers, journalists and politicians and that, unlike previous presidents, he plans to be vocal in his opposition to Trump’s policies.

He said part of his post-presidential strategy would be developing young Democratic leaders — including organizers, journalists and politicians — who could galvanize voters behind a progressive agenda. He won’t hesitate to weigh in on important political debates after he leaves office, he told Axelrod.


Following a period of introspection after he departs the White House, Obama said he would feel a responsibility as a citizen to voice his opinions on major issues gripping the country during Trump’s administration though he would not necessarily weigh in on day-to-day activities.


“At a certain point, you make room for new voices and fresh legs,” Obama said.


“That doesn’t mean that if a year from now, or a year-and-a-half from now, or two years from now, there is an issue of such moment, such import, that isn’t just a debate about a particular tax bill or, you know, a particular policy, but goes to some foundational issues about our democracy that I might not weigh in,” Obama went on. “You know, I’m still a citizen and that carries with it duties and obligations.”


Obama’s first acts out of office, however, will be lower-profile. He said he’ll focus on writing a book and self-analyzing his time in office. Obama and his family plan to live in Washington while his younger daughter finishes high school.


“I have to be quiet for a while. And I don’t mean politically, I mean internally. I have to still myself,” he said. “You have to get back in tune with your center and process what’s happened before you make a bunch of good decisions.”

While we’re happy to see that Obama has de-emphasized the “Russian hacking” narrative in his official talking points, we continue to be stunned by his blissful ignorance to the true underlying causes of Hillary’s loss.

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White House Issues Statement On Phone Call Between Obama And Trump

Following the latest round of sparks to fly between president-elect Trump and outgoing president Obama over the last few days, late on Wednesday the White House released a statement on a phone call held between Obama and Trump. According to the White House, Obama is committing to continuing talks with President-elect Donald Trump, even as Trump accuses him of throwing up “roadblocks” to a smooth transition of power.

The White House also said that Obama called Trump on Wednesday morning from Hawaii, where Obama is on vacation with his family, and added that the call was “positive” and focused on “continuing a smooth and effective transition.”

White House spokesman Eric Schultz says Obama’s other calls with Trump since the election have also been positive. He says Obama and Trump agreed that their teams will keep working together until Inauguration Day on Jan. 20.

On Wednesday morning, Trump lashed out at Obama, whom he accused of putting up “roadblocks” in his transition effort, saying he was “doing my best to disregard the many inflammatory President O statements and roadblocks.Thought it was going to be a smooth transition – NOT!”

Doing my best to disregard the many inflammatory President O statements and roadblocks.Thought it was going to be a smooth transition – NOT!

— Donald J. Trump (@realDonaldTrump) December 28, 2016

But a few hours later Trump’s tone changed, and when speaking to reporters at Mar-a-Lago, Trump described his Wednesday phone call with President Obama as a “very nice conversation,”

“He called me, we had a very nice conversation,” Trump said at his hotel Mar-a-Lago in Palm Beach, Fla., according to pool reports. “We had a general conversation. Very, very nice.”

And so, the two have kissed and made up, if only for the next 12-18 hours. Then, tomorrow morning, the cycle begins anew.

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Will Investors Get ‘Hustled’ By The Pros In 2017?

Submitted by Danielle DiMartino Booth via Money Strong,

It never pays to be an “afterthought.”

That was the word Jackie Gleason used to characterize the proposed reprisal of ‘Minnesota Fats’ in The Color of Money, 1986’s sequel to The Hustler. Chances are Paul Newman himself, who had at least 36 script conferences with the screenwriter, didn’t take offense to Gleason’s rebuff. “We desperately wanted the character to return,” Newman told the New York Times of Gleason’s ‘Fats,’ “but every time we put him in, it seemed like we were trying to glue an arm on a man and make it stick.”

Under the brilliant direction of Martin Scorsese, Newman would go on to win an Oscar for his role in Color. Still, as a whole, the sequel simply couldn’t stand up to the 1961 original. Hence the irony of Newman’s Oscar, which critics suggested was in belated recognition of his original performance as an ace pool player in The Hustler. In his young, glory days, Newman so deeply penetrated his characters’ roles that he literally vanished into them. His brilliance as an actor shined brightest in one scene when Eddie lost to Fats; rather than hostility or animus, his fascinated adoration for his idol was unabashedly on display, reflected in his bright eyes and amused expression. Now that’s Hollywood.

As for Wall Street, it’s recent performance has also laid the drama on thick and in perfect form as stocks pierce record highs. The investor community, the Street’s audience, couldn’t agree more. According to the latest survey from the Conference Board, retail investors’ enthusiasm for the stock market’s prospects is at the highest level since February 2007. A stroll down memory lane reveals that similar readings on the giddiness gauge were contrarian in nature, aka sell signals. That is, unless you’re referring to 1996 as a step-off point. In that case, today’s positive parallels suggest stocks’ 2017 sequel could best the original rally that culminated in the S&P 500 peaking in 2001.

What’s driving the train to stock market stardom? The singular theme since Trump was elected has been happiness bordering on euphoria. The overall December Conference Board survey hit a 15-year high. This echoed the most recent University of Michigan December survey, which hit a 12-year high. But it’s not just your average Joe on the street, as in Main Street. Small business confidence also witnessed its biggest one-month surge since 2009, while regional manufacturing surveys have uniformly topped forecasts. Based on an average of five regional Fed surveys, Morgan Stanley raised to a two-year high its expectations for the upcoming release of the national manufacturing survey.

The question is, can the economic fundamentals Trump the (over?)-heated hope? For that to happen, every bit of optimism has to be substantiated. And that supremely sublime stage has yet to be set.

The entirety of the Conference Board spike was due to expectations; current conditions, which remain high, actually fell on the month. Similarly, small business owners’ expectations for future sales rose smartly, which runs counter to actual sales, hiring and capital expenditures declining last month. And finally, one red flag that’s popped up in multiple places centers on the jobs market. While consumers’ expectations for income growth rose to the highest level in a decade, their perceptions of jobs being ‘plentiful,’ fell while those lamenting jobs were “hard to get” rose, affirming the recent drift upwards in jobless claims.

Some of the regional Fed surveys also showed employment had unexpectedly hit reverse gear, contrary to respondents’ effusive outlook for the future. Most surprising, perhaps, were the losses reported in Texas’ manufacturing sector in November; they defy the recent uptick in rig counts. Renmac’s chief economist Neil Dutta figures the number of operating rigs has surged 120 percent over the third quarter average. That puts the current number of drilling wells at the highest since January; oil maintaining its price gains implies more to come, reflected in Texas manufacturers’ outlook, which hit its highest level in 12 years. Presumably job growth will follow, according to the script, that is, and not just in the Lone Star State. Presumably.

Continuing along the contented motif, homebuilders are downright ecstatic – their optimism is ringing in the new year at the highest level since 2005. As per the National Association of Home Builders (NAHB):

“Builders are hopeful that President-elect Trump will follow through on his pledge to cut burdensome regulations that are harming small businesses and housing affordability. This is particularly important given that a recent NAHB study shows that regulatory costs for home building have increased 29 percent in the past five years.”

Potential homebuyers are also buying in to the potential for falling prices; the NAHB sub-index that measures Prospective Buyers Traffic registered its first print in expansionary territory since August 2005. There’s a good chance the cheery potential homebuyers overlap with the record number of consumers (18 percent) who the University of Michigan reported “spontaneously mentioned the expected favorable impact of Trump’s policies on the economy.” This figure is twice as high as its prior peak, recorded in 1981 as Reagan was taking office.

The teensiest of caveats before continuing – all of this rhapsody is not free; it’s been more than reflected in higher interest rates which have notably manifested themselves in the highest mortgage rates since the bond market threw a taper tantrum in the summer of 2013. Not even Yale economist Robert Shiller can predict which way the winds will blow, good or bad, as he told Bloomberg News:

“I don’t know how people react to rising mortgage rates. One thought is they want to lock in right now. And that’s why we’ve had good home sales recently. And it might continue as mortgage rates rise. This thing could feed a boom. I’m not saying it will.”

Talk about measured!

Paradoxically, households’ inflation expectations looking out five years over the horizon sank to their lowest level on record in data going back to 1979, even as businesses whine about the highest input costs in years.

If you think you’re hearing a wee bit of a mixed message emanating from households and businesses, you’re not losing your marbles. Policymakers and politicians have a heck of a lot to make good on when Congress takes to the Hill and the new administration sets foot in the White House next month.

We can all hope that breaking the gridlock and freeing businesses to conduct business the old-fashioned American way will unleash animal spirits among employers. Job creation, of a meaningful, high-income-generating sort, would thus beget consumption. This in turn would spur the best sort of economic growth we can hope for, and at the same time reflect businesses carrying through on their stated confidence with actions, by expanding their payrolls, inducing a lovely, virtuous cycle that feeds on itself. How economically endearing indeed.

Would you be surprised to discover there are a few skeptics who doubt Goldilocks is primed to whip out those golden locks, validating, well, just about everyone’s cockiness?

Though other perpendiculars have already been posited, it’s fair to interject a friendly reminder that we are not in 1982, the last time stocks were trading at a single-digit price-to-earnings multiple and Baby Boomers were less than half their age. Is it relevant that productivity growth was running at eight times its current pace with the saving rate double where it is today and household debt to income half of where it is? Wait…won’t rising rig counts cap oil prices? And does it matter that Uncle Sam’s debt load has grown to 105 percent of GDP compared to 30 percent back then? Does this country and its inhabitants technically have to have a pot that’s growing in size to piss in?

Not according to the measured volatility on the stock market, which is near the lowest in recorded history. We have nothing to worry about and that’s that. Hence the perplexing pessimism among institutional investors. The State Street Investor Confidence Index (ICI) peaked in March of this year, and after a wimpy stab at a comeback, has retreated anew.

The developers of the ICI observed that 2016 ended on a downbeat note as institutional investors continued to shun the stock market, preferring instead to wait for follow-through from the incoming administration and greater clarity on just how serious the Federal Reserve is about hiking rates in 2017.

“While markets increasingly look to be ‘priced for perfection’ over the US economic outlook for 2017, it is interesting that institutional investors are more circumspect,” said Lee Ferridge, State Street’s head of North American strategy. “Most noteworthy for me is the decline in the North American index even as US equities and the US dollar continue to rise.”

If the stars don’t align perfectly, if the sequel doesn’t best the original, smaller investors might want to wise up to the fact that they’re being hustled by the equivalent of professional gamblers. Know that they’ve been at this game for long enough to cash out their winnings while they can still be put to good use. What’s the alternative? That would be investors finding themselves in naïve form, as Fast Eddie did, just before he lost to Minnesota Fats, asking, “How can I lose?

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More Bad News For NYC Real Estate As Luxury Co-Op Contracts Collapse 25%

Luxury real estate broker Olshan Realty, Inc. has some bad news for New York’s hedge fund managers looking to dump their luxury $5 million, 1,500 square foot palaces as the market for luxury New York City real estate just might be on the verge of collapse.  Accroding to a year end report published by Olshan, contracts for luxury co-ops (defined as those with an asking price above $4mm) collapsed 25% in 2016 while the average number of days that apartments sat on the market surged 31% and discounts to original listing price also jumped a point to 6%.

The decline reflects classic price resistance. There was a 2% increase in the average asking price, but a 30% increase in the average days on the market—318 days. You read that right—it took more than two months longer to sell a luxury property in 2016 than in 2015. The average price drop from listing to contract signing was 6%, an increase from 5% in 2015. There was also a 5% decline in contracts signed at $10 million and above.


The steepest fall from grace was in co-ops: 25% fewer contracts at $4 million and above from 2015, signaling a continuing market shift in the luxury market to new condos that offer freedom of ownership, new infrastructure, robust amenities, and some hip architecture—particularly seen Downtown.

NYC Condos


Of course, this news should come as little surprise to our readers as we’ve frequently written about the unintended consequences of the massive overbuild of luxury apartment inventory over the past several years in Manhattan. 

In fact, a few weeks ago we warned New York City apartment owners to take note of the latest 3Q16 “Elliman Report” that showed the number of apartment closings had plunged 18.6% YoY while apartments sat on the market an average of 8.2% longer.  Inventory also spiked with new development inventory up a massive 27.2%.   

The number of re-sales has fallen year over year in each of the last four quarters at an increasing rate.  Listing inventory reflected significant differences in the rate of growth between re-sale and new development.  Re-sale inventory expanded 8.2% to 5,290 while new development inventory surged 27.2% to 973 respectively from the same period a year ago.

NYC Real Estate


Meanwhile, the re-sale market looked even more bleak, on a standalone basis, as the number of closings collapsed over 20% YoY while days on the market increased 7.5%

NYC Real Estate


The lesson seems to be that the marginal New York City buyer has been priced out of the market while sellers have not yet accepted that the bubble has burst deciding instead to maintain listing prices while letting their apartments sit on the market longer amid growing inventory levels…that should work out well…

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